Questions on policy types are a large share of every life insurance exam. Each type is easiest to remember by the one feature that sets it apart.
Term life
Term insurance covers the insured for a set period. If the insured is alive when the term ends, the policy pays nothing. A non-renewable term policy simply ends, and the owner must apply for new coverage to stay insured.
Whole life
Whole life (also called straight life) charges a level premium for life. In the early years the premium is more than the cost of the protection, and that excess builds a reserve and a cash value that helps pay for the later years. In a non-participating policy both the premium and the face amount stay level for the insured's whole life.
- Limited-payment whole life squeezes the premiums into fewer years, for example a policy paid up at age 65 so no premiums are due after retirement.
- Single premium whole life is the extreme case of limited payment: one premium, with cash and loan values from the start. Its main appeal is the tax-deferred growth of that cash value.
- Modified whole life charges a lower premium for the first few years and a higher-than-regular premium afterward.
Universal life
Universal life separates the policy into its parts: premiums go into an account, and the insurer deducts mortality and expense charges from it. The owner can vary premium payments within limits. The mortality charges rise as the insured grows older, which matters if the account is underfunded.
Variable life and variable universal life
In a variable policy the cash value is invested in accounts the owner chooses, and the policyowner bears the investment risk. Variable universal life adds universal life's flexibility. The SEC warns that fees, poor investment results or loans can drain the cash value and lapse the policy even when the planned premiums are paid. Selling variable products takes both an insurance license and a securities registration.
Policies on more than one life
- Joint life covers two people and pays at the first death.
- Joint and last survivor (survivorship) pays at the second death.
- A family policy insures several family members in one contract, typically whole life on the main breadwinner and term on the spouse and children.
A tax rule worth knowing
A policy funded too quickly fails the federal 7-pay test and becomes a modified endowment contract (MEC), which changes how money taken out of it is taxed. A single premium policy is the classic example.